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Bank of England on the sidelines as rates are left unchanged at 0.5%

Last week’s meeting of the Bank of England’s Monetary Policy Committee (MPC) concluded in line with market expectations, with no changes to policy writes Oliver Mangan Chief Economist at AIB.

For a second consecutive month, the decision to leave rates unchanged, at 0.5%, was unanimous, with all members of the committee of the view that “maintaining the current stance of policy was appropriate”. While inflation in the UK has ticked up recently, as noted by the BoE, it remains “well below the 2% inflation target”.

Of particular concern is that “core inflation also remains subdued”, due to a combination of past sterling strength, weak global inflation, and limited domestic cost growth.

The most recent BoE macro forecasts were contained in its February Quarterly Inflation Report (QIR), and included downward revisions of its inflation and growth forecasts, compared to its November QIR. The bank expects CPI inflation to pick up to just 0.9% by the final quarter of this year, down from its previous forecast of 1.1%. Inflation is forecast to have risen to 1.9% by the end of 2017.

There was also a lowering of the bank’s wage-inflation forecasts. It now projects that growth in average weekly earnings will be 3% by the end of this year. Meanwhile, GDP projections see growth at 2.2% this year and 2.3% in 2017, in line with the outturn for last year, when the economy grew by 2.2%.

Growth in the UK is heavily reliant on domestic demand, especially consumer spending, with net external trade remaining a drag on GDP, as exports continue to struggle. The MPC’s assessment of the global economic outlook, at last week’s meeting, was that the risks to its central projection of “only modest global growth lie to the downside”. At the same time, on the domestic front, Brexit has been a key talking point this month. The post-meeting statement said that “there appears to be increased uncertainty surrounding the forthcoming referendum”.

The MPC said that this uncertainty was likely to have been a significant driver of the recent decline in sterling, and it could also “delay some spending decisions and depress growth of aggregate demand in the near term”. Despite this, though, the MPC judges the “outlook for domestic activity to be little changed” since its last meeting in February.

Overall, the evidence from the March BoE meeting continues to suggest that the bank is still some way off from starting to hike interest rates. There remains a “spread of views” among members of the MPC, on the inflation outlook, especially in relation to how “wages would respond to the past declines in unemployment and the prospective increase in inflation”.

In terms of market expectations, futures contracts do not envisage a UK rate hike materialising until the second-half of 2018. There is only one rate hike, of 25 basis points, priced in for that year, which would bring the bank rate up to just 0.75% by the end of 2018. However, given that the BoE repeated its stance that “it is more likely than not that the bank rate will need to increase over the forecast period”, markets may be too relaxed on their UK rate-hike expectations.

With the unemployment rate already down near 5%, we could see the BoE hiking rates next year, if the UK economy continues to grow solidly, if the downside influence on inflation, from the sharp decline in commodity prices over the past two years, eases, and if domestic cost-pressures start to help push inflation up closer to the MPC’s 2% inflation target.

The Brexit referendum could also play a crucial part in the BoE’s deliberations on interest rates. A vote to leave the EU will introduce a considerable amount of uncertainty and could see a slowdown in the UK economy. The BoE is likely to keep rates on hold for an extended period of time, in these circumstances. A vote to remain in the EU would lift a lot of uncertainty on the future prospects for the UK economy and may well give a boost to activity later this year, and into 2017.

This could be sufficient to bring a rate hike onto the agenda next year, especially if the recovery in commodity prices in recent weeks proves sustained, as this will boost inflation.

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